W | Investing to Build an Empire that Should't Exist

Takeaway:W continues to build an infrastructure for a TAM that does not exist. Our research contends TAM for W is $27bn today, not $90bn.

Investing to Build an Empire that Does Not Exist

The top line growth is impressive with the direct business up 98% with delivered orders up 82% and average ticket up 9%. That’s great at face value. But the company added $339mm in revenue year/year, and only $9mm in incremental EBIT. AND it still put up a negative EBIT number. Also, we’re starting to see customer acquisition costs go up on the margin, and advertising efficacy go down. At the same time the company continues to build an enormous infrastructure of people (employee growth accelerated to +17% sequentially vs 14% in 3Q) for a Total Addressable Market that does not exist. Our research contends that the TAM for W is $27bn today, compared to management’s assertion that it’s market is $90bn. That is absolutely unrealistic. That might not matter today, given that Restoration Hardware’s miss is making Wayfair look like a champ. But we continue to believe that this company will never run a profitable business. All the signs are there.

Performance Metrics:

Customer Growth

Sequential customer growth accelerated in Q4 , and grew 67% in 2015, faster than the 54% growth last year.

However if we look at ad spend per incremental customer, and incremental advertising per incremental customer, both metrics weakened significantly in Q4.

Growing Average Order

Average order growth accelerated to 8.8% against a tougher comp. This is a clear positive for the company. Since it is unlikely the average price of merchandise assortment has changed materially, this means customers are spending more at Wayfair.

Ad Efficiency Slowing

Looking at revenue dollars generated per advertising dollar, it grew 12.8% yy, but slowed significantly from 3Q and was the lowest growth rate in 2015.

In summary, our multi-duration outlook for the USD would seem to suggest the counter-TREND bounce that’s been distributed across various reflation sectors and assets (e.g. materials, industrials, gold, gold miners, EM) is likely to peter out at some point over the next 4-6 weeks.

While there is likely still money to be made on the long side for traders and high-turnover funds, we think long-term investors would do well to avoid getting sucked into the aforementioned reflation head-fake ahead of a likely crescendo.

DD

Darius Dale

Director

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02/25/16 11:02 AM EST

This Economic Indicator Slips For First Time Since Great Recession

The chorus of market prognosticators loudly proclaiming "all is good" in the U.S. economy seems to swell almost daily. (Overly optimistic Fed presidents are often the loudest in the bunch.) But the data continues to confirm otherwise.

It's interesting. Four or five months ago, virtually no one was talking about the prospect of recession. Now, at a bare minimum, it's at least a highly-clickable headline for the media to question growth slowing deniers about.

Each day the economic data continues to bolster our U.S. #GrowthSlowing call. (In January, we signaled that the likelihood of a U.S. #Recession sometime in the next one to three quarters is rising.) Here's the latest growth slowing indicator and analysis from our Macro team sent to subscribers this morning:

"Amazingly, the Markit Service Sector PMI falling into contraction for the 1st time since the Great Recession got almost zero media coverage yesterday. Services Consumption represents ~65% of household spending and ~45% of GDP and has hereto been held out as the bullish foil for the ongoing industrial recession.

The ISM Services Index has shown a similar trend – slowing in each of the last 3 months and, at the current index reading of 53.5, sits at its lowest level since the polar vortex lows of February 2014."

Eurozone, #GrowthSlowing and #Gold

Client Talking Points

EUROZONE

Got inflation? Eurozone CPI fell 10 basis points to 0.30% year-over-year in a final January reading. The ECB meets next on March 10th – this print taken alongside recent rhetoric from ECB heads suggests the increased likelihood the Bank acts to increase its QE program. Remember, its goal is to stoke inflation anyway it can, even if QE can’t accomplish this, or spur growth. #EuropeSlowing

#GROWTHSLOWING

Amazingly, the Markit Service Sector PMI falling into contraction for the 1st time since the Great Recession got almost zero media coverage yesterday. Services Consumption represents ~65% of household spending and ~45% of GDP and has hereto been held out as the bullish foil for the ongoing industrial recession. The ISM Services Index has shown a similar trend – slowing in each of the last 3 months and, at the current index reading of 53.5, sits at its lowest level since the polar vortex lows of February 2014.

#GOLD

Gold loves nothing more than down dollar and interest rates. With consensus positioned for a stronger USD and a series of rate hikes into 2016, gold has sniffed out growth slowing data and market turmoil. In consequence, Gold and Silver are leading CRB divergences YTD at +16.6% and +10.3% YTD against a weaker USD (-1.3% YTD) and a 10-Year Yield that continues to price in slower growth, backing off -51bps on the year, at 1.74% this morning. While the Fed continues to play hardball on the direction of policy in 2016, the market trades skeptical.

*Tune into The Macro Show with Darius Dale and Ben Ryan live in the studio at 9:00AM ET - CLICK HERE.

Asset Allocation

CASH

63%

US EQUITIES

0%

INTL EQUITIES

0%

COMMODITIES

4%

FIXED INCOME

25%

INTL CURRENCIES

8%

Top Long Ideas

Company

Ticker

Sector

Duration

xlu

Long-Term Treasuries (TLT) and Utilities (XLU) remain our two best fixed income and equity vehicles to play #Lower-For-Longer on growth and interest rates as the market gets more and more skeptical about the central bank dogma.

With market turmoil, the Junk Bond ETF (JNK) is down -4.5% vs. the defensive, growth slowing equity sector Utilities (XLU) which is up 6.7%, outperforming the S&P 500 by 12.9% on a relative basis. That’s yet more confirmation of our dour economic outlook economy (spreads widen in tumultuous market environments and Utilities are a defensive sector that outperforms when growth is slowing).

gis

General Mills (GIS) is a large player in the Yogurt category with their Yoplait brand. Their competitors, Dannon, Chobani and Fage have been aggressive on merchandising and consumer spending, making it difficult to compete while maintaining internal margin objectives. GIS is turning on innovation with the growth of Annie’s yogurt and that should help the trajectory of the business. Yogurt being a roughly $1.4 billion business, turning it around is a top priority for management.

On the broader GIS long thesis, it's unlikely that the stock is going to go up 20% in the next year, but we do believe it will fare better than most in the consumer staples sector, especially as we head into an economic slowdown.

TLT

With the market losing faith in the central planning policy backstop, investors continue to yield to top-down market signals and the direction of the data. To be clear, the data continues to deteriorate and volatility continues to break-out.

The yield spread (10-year Treasury yield minus 2-year Treasury yield) has compressed 24 basis points this year, and TLT is up 8.6% vs. the S&P 500 which is down -5.2%. The December Federal Funds Futures contract has declined in a straight line since December’s rate hike.

ICI Fund Flow Survey | Small Reprieve from Taxable Drawdowns

Takeaway:Investors made the first contribution to taxable bonds in 15 weeks, although only a modest +$107 million.

Investment Company Institute Mutual Fund Data and ETF Money Flow:

In the 5-day period ending February 17th, taxable bond funds saw their first inflow in 15 weeks, although only a modest +$107 million. Also within bonds, fixed income ETFs took in +$2.9 billion. That amount included +$448 million in contributions to the long duration Treasury TLT fund, which has now increased year-to-date assets by an astounding +$3.0 billion or +44%. Meanwhile, investors continue to exit equity mutual funds and ETFs, drawing down another -$4.1 billion from the category, even during a week with declining volatility. International equity funds, however, were the exception within total equity products, taking in +$1.0 billion, as the category continues to experience stable inflows. Finally, investors seeking safety shored up +$8 billion in money market funds as the move to build cash is accelerating.

In the most recent 5-day period ending February 17th, total equity mutual funds put up net outflows of -$1.2 billion, trailing the year-to-date weekly average outflow of -$1.0 billion but outpacing the 2015 average outflow of -$1.5 billion. The outflow was composed of international stock fund contributions of +$1.0 billion and domestic stock fund withdrawals of -$2.3 billion. International equity funds have had positive flows in 41 of the last 52 weeks while domestic equity funds have had only 5 weeks of positive flows over the same time period.

Fixed income mutual funds put up net inflows of +$964 million, outpacing the year-to-date weekly average outflow of -$873 million and the 2015 average outflow of -$475 million. The inflow was composed of tax-free or municipal bond funds contributions of +$857 million and taxable bond funds contributions of +$107 million.

Equity ETFs had net redemptions of -$2.9 billion, slightly better than the year-to-date weekly average outflow of -$4.4 billion but trailing the 2015 average inflow of +$2.8 billion. Fixed income ETFs had net inflows of +$2.9 billion, outpacing the year-to-date weekly average inflow of +$2.4 billion and the 2015 average inflow of +$1.0 billion.

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.

Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2015 and the weekly year-to-date average for 2016:

Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.

Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2015, and the weekly year-to-date average for 2016. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:

Sector and Asset Class Weekly ETF and Year-to-Date Results: With Treasury inflows trending, the long duration Treasury TLT ETF took in another +$448 million or +5% last week. Also, the utilities XLU fund took in +$469 million or +6%.

Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.

Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$8.0 billion spread for the week (-$4.1 billion of total equity outflow net of the +$3.9 billion inflow to fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$475 million (more positive money flow to equities) with a 52-week high of +$20.5 billion (more positive money flow to equities) and a 52-week low of -$19.0 billion (negative numbers imply more positive money flow to bonds for the week.)

Exposures: The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:

Jonathan Casteleyn, CFA, CMT

Joshua Steiner, CFA

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02/25/16 08:13 AM EST

CHART OF THE DAY: New Home Sales Throw Up A Brick

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye U.S. Macro analyst Christian Drake. Click here to learn more.

"... Brick!: New Home Sales threw up a brick to start 2016, falling to -5.2% YoY and marking the slowest pace of growth and the 1st negative year-over-year print since June of 2014. The median price of New Homes declined -5.7% MoM and decelerated to -4.5% YoY – the 1st consecutive months of YoY decline since 2011. Further, sales growth was 0% or negative across all price tiers for the first time since the 2014 trough.

Yes, the outsized decline in the West region (weather impact) was likely a distortion that resolves higher but I also didn’t hear anyone call out the 100% YoY gain in the Northeast (weather benefit) as a positive distortion. NHS is the most volatile housing series there is and carries a large standard error with significant subsequent revisions so we don’t take an overly convicted view of any single month in isolation but as the Chart of the Day below shows, the multi-month trend across New Home Sales and Starts has been one of slowing."

Risk Managed Long Term Investing for Pros

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